Renegotiation of the Standard Reinsurance Agreement (SRA) for Federal Crop Insurance

Renegotiation of the Standard Reinsurance Agreement (SRA) for Federal Crop Insurance Dennis A. Shields Specialist in Agricultural Policy August 12, 2010 Congressional Research Service 7-5700 www.crs.gov R40966 CRS Report for Congress Prepared for Members and Committees of Congress Renegotiation of the Standard Reinsurance Agreement (SRA) for Federal Crop Insurance Summary Under the federal crop insurance program, farmers can purchase crop insurance policies to manage financial risks associated with declines in crop yields and/or revenue. The program covers more than 100 crops and is administered by the U.S. Department of Agriculture’s (USDA’s) Risk Management Agency (RMA), which acts as both regulator and reinsurer. To encourage farmer participation and reduce the need for ad hoc disaster assistance, the federal government subsidizes the purchase of crop insurance policies, which are sold and serviced through 16 approved private insurance companies. Insurance company losses are reinsured by USDA, and their administrative and operating (A&O) costs are reimbursed by the government. A Standard ReinsuranceAgreement (SRA) between USDA and the private companies spells out expense reimbursements and risk-sharing by the government, including the terms under which the government provides subsidies and reinsurance (i.e., insurance for insurance companies) on eligible crop insurance contracts sold or reinsured by insurance companies. As a result, the SRA plays a central role in determining program costs. The SRA does not affect policy premiums paid by farmers, which are based on RMA’s estimates of risk and on subsides set in statute. As provided under the 2008 farm bill, USDA in late 2009 began renegotiating the SRA established in 2004. On July 13, 2010, USDA announced that all of the approved crop insurance companies had signed the new SRA, which covers crops with policy closing dates after July 1, 2010 (e.g., 2011-crop corn). Prior to and during the negotiations, some had criticized the previous SRA as being too generous for insurance companies following a significant increase in government costs in recent years. Although Congress does not directly approve any new agreement, Congress has been interested in its oversight capacity, particularly with respect to cost-effectiveness and effects on farmer participation, the industry’s selling and servicing of crop insurance products to farmers, and baseline funding levels for the next farm bill. Since A&O reimbursements under the previous SRAwere based on a percentage of premiums, their dollar amount had risen sharply in recent years as premiums rose to reflect higher crop prices. TheA&O reimbursement increased from an average of $881 million during FY2004-FY2006 to $1.6 billion in 2009. Similarly, company underwriting gains (the amount by which a company’s share of retained premiums exceeds its indemnities) have increased substantially in recent years, as weather has been generally favorable for growing crops. Some have argued that if the government share of gains is increased in exchange for a larger government share of losses, average taxpayer costs would decline. The insurance industry has contended that a certain SRA provision (“net book quota share”) is a tax on underwriting income and crowds out private reinsurance. RMA released its first draft of the 2011 SRA on December 4, 2009, a second draft in mid-February 2010, and a “final” draft on June 10, 2010. The final SRA places a cap onA&O reimbursements to control costs, and limits a company’s expenditures on agent commissions. Among the changes to underwriting provisions, the final SRA improves profit potential and reduces company risk in higher-risk and underserved states. Overall, USDAexpects the changes to save $6 billion over 10 years. The industry remains concerned that funding reductions are excessive, potentially jeopardizing program delivery to farmers. Congressional Research Service Renegotiation of the Standard Reinsurance Agreement (SRA) for Federal Crop Insurance Contents Introduction................................................................................................................................1 Crop Insurance Background........................................................................................................2 Federal Program Costs................................................................................................................2 Major Provisions in the Standard ReinsuranceAgreement for 2010.............................................4 Reinsurance..........................................................................................................................4 Assigned Risk Fund........................................................................................................6 Developmental Fund.......................................................................................................6 Commercial Fund ...........................................................................................................6 A&O Reimbursement............................................................................................................7 General Provisions................................................................................................................7 Studies on Rates of Return..........................................................................................................8 Issues in the SRA Renegotiation..................................................................................................8 Cost Control and Financial Viability of Crop Insurance Companies.......................................9 A&O Reimbursements....................................................................................................9 Underwriting.................................................................................................................10 Crop InsuranceAvailability and Farmer Participation..........................................................10 Uncertainties After Completion of SRA Renegotiation........................................................11 Developing the 2011 SRA.........................................................................................................12 USDA’s First Draft SRA.....................................................................................................12 Industry Response to USDA’s First Draft ............................................................................13 USDA’s Second Draft SRA.................................................................................................14 Budget Implications......................................................................................................15 2011 SRA Signed by Companies.........................................................................................15 Figures Figure 1. Government Costs for Crop Insurance Have Increased Sharply.....................................4 Tables Table 1. Government Cost of Federal Crop Insurance..................................................................3 Contacts Author Contact Information......................................................................................................17 Congressional Research Service Renegotiation of the Standard Reinsurance Agreement (SRA) for Federal Crop Insurance Introduction Under the federal crop insurance program, farmers can purchase crop insurance policies to manage financial risks associated with declines in crop yields and/or revenue. The program, which began in 1938 when Congress authorized the Federal Crop Insurance Corporation (FCIC) and now covers more than 100 crops, is administered by the U.S. Department of Agriculture’s (USDA’s) Risk Management Agency (RMA), which acts as both regulator and reinsurer. A Standard ReinsuranceAgreement (SRA) between USDA and the private companies spells out expense reimbursements and risk-sharing by the federal government, including the terms under which FCIC provides subsidies and reinsurance (i.e., insurance for insurance companies) on eligible crop insurance contracts sold or reinsured by insurance companies. As a result, the SRA plays a central role in determining program costs. In late 2009, RMA began the process of renegotiating the SRAestablished in 2004. In the run-up to the negotiations, some had criticized it as being too generous for insurance companies following a significant increase in government costs in recent years, driven in part by rising crop prices. The 2008 farm bill (P.L. 110-246) allows USDA to renegotiate the SRA once every five years starting with the 2011 reinsurance year (which runs from July 1, 2010, through June 30, 2011).1 The negotiation process involved USDAdeveloping a draft agreement, meeting separately with the insurance companies, and responding to the comments, concerns, and suggestions of the insurance companies and the public. On June 10, 2010, RMA issued what it called the final draft of a new SRA to cover the 2011 reinsurance year and subsequent years.2 On July 13, 2010, USDA announced that the agreement had been signed by all 16 approved insurance companies, putting it into effect for the 2011 reinsurance year. This report discusses federal crop insurance costs, the SRA that had been in effect for the 2010 reinsurance year, and issues related to the renegotiation of the SRA. Although Congress does not directly approve any new agreement, Congress has been interested in the SRA negotiation in an oversight capacity, particularly with respect to cost-effectiveness and changes that might affect farmer participation, policy coverage, or industry interest in selling crop insurance to farmers.3 Another congressional concern has been how cuts in crop insurance expenditures stemming from a new SRAmight affect baseline spending levels used for determining funding for the next farm bill.4 1 The reinsurance year for a crop insurance policy is determined by its sales closing date. For example, a policy for 2010-crop corn is covered under the 2010 standard reinsurance agreement because the sales closing date is March 15, 2010 (in most cases). 2 U.S. Department of Agriculture, “USDA Releases Final Draft Crop Insurance Agreement,” press release, June 10, 2010, http://www.usda.gov/wps/portal/usda/usdahome?contentidonly=true&contentid=2010/06/0316.xml. 3 Office of Senator Blanche Lincoln, “Lincoln, Chambliss Urge USDA to Revisit Crop Insurance Changes,” press release, January 20, 2010. See also Office of U.S. Representative Stephanie Herseth Sandlin, “Herseth Sandlin Works to Ensure Producer Access to Crop Insurance,” press release, January 22, 2010. 4 Jerry Hagstrom, “Peterson Floats Reconciliation for Farm Bill,” CongressDaily, February 16, 2010, http://www.nationaljournal.com/congressdaily/cop_20100216_5206.php. Congressional Research Service 1 Renegotiation of the Standard Reinsurance Agreement (SRA) for Federal Crop Insurance Crop Insurance Background Congress first authorized federal crop insurance as an experiment to address the effects of the Great Depression and crop losses in the Dust Bowl. In 1938, the Federal Crop Insurance Corporation (FCIC) was created to carry out the program, which focused on major crops in major producing regions. The federal crop insurance program remained limited until passage of the Federal Crop InsuranceAct of 1980 (P.L. 96-365), which expanded crop insurance to many more crops and regions of the country. Congress enhanced the crop insurance program in 1994 and again in 2000 to encourage greater participation. The changes also expanded the role of the private sector in developing new products that would help farmers manage their risks. To encourage farmer participation and reduce the need for ad hoc disaster assistance, the federal government subsidizes the purchase of crop insurance policies, which are sold and completely serviced through 16 approved private insurance companies. Independent insurance agents are paid sales commissions by the companies. Insurance company losses are reinsured by USDA, and their administrative and operating costs are reimbursed by the federal government. These costs include payroll, rent, commissions to agents, and expenses for adjusting claims (e.g., traveling to farmers’ fields). The SRAdoes not affect policy premiums paid by farmers, which are based on RMA’s estimates of risk and on subsides set in statute. The premiums depend in part on crop price levels, coverage levels that producers select, and policy type (e.g., yield-based or revenue-based). The expense reimbursement is currently calculated as a share of policy premiums. For more information on crop insurance policies, see CRS Report R40532, Federal Crop Insurance: Background and Issues, by Dennis A. Shields. Federal Program Costs Federal program costs for crop insurance fall into one of four main categories: premium subsidies, administrative and operating (A&O) expense reimbursement, program losses (or gains), and other (Table 1). The SRAessentially defines the parameters that eventually determine A&O expense reimbursements and program losses (or gains). Premium subsidies are specified in the Federal Crop InsuranceAct of 1980 (P.L. 110-365), as amended. Periodic legislation can also affect federal outlays (see “A&O Reimbursement,” below). The largest cost category is premium subsidies, which lower the cost to farmers of purchasing insurance policies. When purchasing a policy, a producer growing an insurable crop selects a level of coverage and pays a portion of the premium. The remainder of the premium is covered by the federal government. Nearly 60% of total premium, on average, is paid by the government. As with other insurance, premiums increase with additional coverage, in terms of greater price protection or yield protection (or both). The second-largest cost category is A&O expense reimbursement. Unlike some other insurance products, premiums for crop insurance are not “expense loaded.” For crop insurance, the entire premium covers only the liability associated with payment of crop losses and excludes expenses for delivery of the product. Currently, expense reimbursement for insurance companies is directly related to the value of the premiums. Therefore, as premiums rise, so does the A&O expense reimbursement, even if other factors, such as the number of policies sold, remain unchanged. Congressional Research Service 2 ... - tailieumienphi.vn